16. Burns Company is considering developing a new operating system for MP3 players. Because of the pace of technology, the software will be obsolete in 3 years, but there is a 35% chance that it will become obsolete after only 1 year. The operating system will cost $700,000 to develop, and will generate income of $400,000 each year. If the software does become obsolete after a year, Burns could sell its patent to another company during the second year, which could adapt the programming for other purposes. Burns estimates that it can sell the patent for $80,000. Burns has an 10% required rate of return.

a. Calculate the net present value of the project using the expected value of its future cash flows, without considering choices available to management.

b. Calculate the value of the project using real options analysis.

c. Calculate the value of the real options associated with the project.